International Trade, Firm Heterogeneity, and Intermediation Horst Raff, University of Kiel

RaffTrade, Heterogeneity,

Intermediation1

International Trade, Firm Heterogeneity, and Intermediation

Horst Raff, University of Kiel

Zhejiang University17-19 May 2011


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International Trade with Heterogeneous Firmsi. Introductionii. Trade Model with Monoplistic Competition (Krugman)iii. Monopolistic Competition with Heterogeneous Firms (Melitz,

Ottaviano)iv. Reciprocal Dumping Model (Brander)v. Reciprocal Dumping Model with Heterogeneous Firms (Long,

Raff, Stähler)vi. Trade and Innovationvii. Intra-Industry Adjustment to Import Competition

Intermediation in International Tradei. Introductionii. Buyer Power in International Marketsiii. Imports and the Structure of Retail Marketsiv. Manufacturers and Retailers in the Global Economy

Syllabus


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Intermediaries in International Trade

1. Role of retailers/wholesalers in intermediating international trade

2. Welfare effects of trade liberalization when there are big, powerful buyers who may capture rents from manufacturers and/or consumers

3. Effect of retail market structure and retail margins on pass-through of import prices into consumer prices

4. Effect of retail regulation on trade and pass-through5. Structural shifts in employment from manufacturing

into retailing6. Retailers as gatekeepers to consumer markets

Introduction


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Buyer Power in International Markets

Horst Raff and Nicolas Schmitt

Journal of International Economics 2009

Buyer Power


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Buyer power:

Exercise of significant market power by retailers/wholesalers

What is the impact of buyer power on international markets:

• the volume of international trade

• the terms of trade

• consumer prices

• domestic welfare/gains from trade?

Buyer Power


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Stylized facts In many countries, retailers and wholesalers have become

significantly more powerful in recent years compared to manufacturers.

In EU food retailing, the concentration ratio rose by 20% between 1993 and 1999.

The aggregate concentration ratio is much higher than in manufacturing: • the 20 largest retailing firms account for 43% of aggregate EU

retail food turnover• equivalent number for manufacturing: only 14.5%.

The same phenomenon has been observed in many other markets, such as apparel and clothing.

In these markets, the retailers impose contract terms on manufacturers, not the other way round.

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Wal-Mart which is today the world's biggest company by sales (US$312.4 billion).

Procter & Gamble employs 200 people who work solely on the Wal-Mart account. The company, along with many others in the Fortune 500, set up offices in northwest Arkansas to be more accessible to Wal-Mart, its largest client.

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Source: Basker and Van (2005), p. 50


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Why is it important to look at buyer power from a trade perspective?

1. Retailers with buyer power participate extensively in international markets:

• Wal-Mart alone accounted for an incredible 10% of total US imports from China in 2004 (Basker and Hoang Van, 2005; Fishman, 2006).

• Wal-Mart imports more than half of its non-food products (Smith, 2004).

• In the apparel market, 12% of the apparel sold by US retailers in 1975 were imported against 48% in 1993.

Buyer Power


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• Without buyer power, imports from China and other developing countries would not have grown as quickly as they did over the last decade.

- Pressure from big retailers (Wal-Mart) has forced domestic suppliers to relocate production abroad.

- Major retailers also buy directly from low cost countries. Most major US retailers have overseas buying offices, especially in East Asia, with contacts with a large network of suppliers.

- In 2002, Wal-Mart took over Pacific Resources Exports (PREL), its exclusive global buyer between 1989 and 2002. PREL lists over 6000 suppliers, 80% of which are located in China

Buyer Power


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Source: Basker and Van (2005), p. 50


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• Role of big buyers may be crucial in understanding why, despite formidable spatial and cultural distances, countries like Japan, South Korea, Taiwan, Hong Kong, Singapore, and now China have been so successful and for so long in exporting to Western countries.

• East Asian growth in trade may be better explained by the role of buyer-driven global commodity chains than by more traditional explanations, such as the role of export-oriented policies (Gereffi, 1999).

• But buyer power has also been blamed for limiting trade by making import penetration more difficult than it would otherwise have been, thanks in particular to the use of exclusive agreements.

Buyer Power


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Why is it important to look at buyer power from a trade perspective?

2. Why does buyer power seem to be on the rise?

• Fundamental reason: greater prevalence of differentiated products in international markets.

• These goods require a lot of information and a good match between the characteristics of buyers and sellers (Rauch and Feenstra, 1999).

• Prices are not enough to convey the necessary information; hence some institutions must emerge to handle these issues.

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• If buyers are in the driving seat, it must because they know consumers' characteristics better than segmented and/or distant suppliers. Buyer power may occur naturally in association with international markets.

• Buyer power can have far-reaching effects on international markets.

• But it is far from clear whether buyer power should increase or decrease trade and welfare.

• Hence, it seems important to start investigating the role of buyer power for international markets.

Buyer Power


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Buyer Power and Welfare – IO Perspective Countervailing power hypothesis (Galbraith, 1952): buyer power

counteracts seller power (second-best solution). If sellers have little or no power, increased buyer power

unambiguously leads to higher retail prices and lower welfare. Recent IO literature looks at implications for prices and welfare of

different contractual tools big buyers may employ w.r.t. to manufacturers:

• Marx and Shaffer (2004), Rey and al. (2005), Inderst and Wey (2004)

• General conclusion: retailers with market power have considerable scope for anti-competitive behavior.

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Our approach• Start from recent IO literature by looking explicitly at

the contractual arrangements between buyers and sellers.

• Extend the analysis to an international environment characterized by barriers to trade and asymmetries in the market shares of manufacturers.

• How does trade liberalization affect consumer prices and welfare in the presence of buyer power?

• How does this compares to a world in which producers have market power?

Buyer Power


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Trade Literature on Intermediaries• Rauch (2001) on the role of networks in international trade,

• Feenstra and Hanson (2004) on the role of Hong Kong intermediaries with respect to Chinese products,

• Raff and Schmitt (2005, 2006) on the role of exclusive territory

and exclusive dealing in international markets

• Richardson (2004) on the comparison between exclusivity in the distribution of domestic products and trade policy to restrict the market access of foreign producers.

• Basker and Van (2005): only paper on buyer power in an international trade context. Focus is different from ours since they want to explain why, in the presence of economies of scale in retailing and in the import process, trade liberalization has led to an explosion of imports by large buyers.

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Model

Two differentiated retailers, R1 and R2, who distribute a homogeneous product in the domestic market.

The product can be obtained from a domestic manufacturer, h, and/or a foreign manufacturer, f.

Costs:• Marginal production cost: c• Marginal cost of distribution: zero

Preferences:

where q‘s are quantities bought from the retailers.

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• Demand faced by retailer i=1,2:

• Contracts:- Retailer i offers two-part tariffs to manuf. j, contingent on

exclusivity E or no exclusivity N (j may sell to rival retailer)

• Timing of the game1. Retailers make take-it-or-leave-it offers to manufacturers.

2. Manufacturers accept or reject contracts from one or both retailers.

3. Contracts are implemented and retailers compete in prices.

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Approach: Derive equilibrium in autarky, where retailers can only by from

manuf. h (Rey, Thal and Verge, 2005) Then derive equilibrium in free trade, where both manufacturers

are active. Compare equilibrium prices and welfare in the two cases. Extend results to the case of positive, non-prohibitive trade

costs.

Two equilibrium outcomes: Exclusive contracts (E): manuf. sign exclusive contracts with

one retailer, the other retailer does not sell Non-exclusive contracts (N): both retailers are active (either

non-exclusive contracts or each retailer has exclusive contract with a separate manuf.)

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Autarky – Exclusive contract equilibria• Contracts:

- conditional on exclusivity, offer the manufacturer a wholesale price equal to marginal cost and a fixed transfer equal to the entire monopoly profit,

- for non-exclusivity, zero transfer. • Manuf. h accepts one of the exclusive contracts.• These equilibria always exist - trivially.• Retailers compete to be the exclusive retailer, and are forced to give

up the entire profit to the manuf.

• Equilibrium prices:- demand faced by the active retailer: q=1-p- wholesale price: c- retail price:- manuf. profit:

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Autarky - Non-exclusive equilibria• Consider the one that is Pareto-undominated for the retailers. • Two equilibrium conditions:

1. Manuf. must be indifferent between accepting one retailer's exclusive contract and accepting both retailers non-exclusive contracts.

2. Wholesale price offered by retailer i has to maximize the joint profit of retailer i and the manuf. given the wholesale price offered by the rival retailer -i.

• Equilibrium wholesale price:

• Equilibrium retail price:

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• Equilibrium existence:

- Necessary condition for existence of a non-exclusive equilibrium: joint profit of the manufacturer and both retailers in the non-exclusive equilibrium exceeds the joint profit of a single retailer-manufacturer pair under exclusive contracts.

- This is satisfied if b≤0.73205, i.e., when the retailers are sufficiently differentiated.

- Only in this case are there enough rents to prevent retailers

from deviating to offering an exclusive distribution arrangement to the manufacturer.

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0 1 b0,73205

Exclusive

Non-exclusive

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Free Trade – Exclusive contract equilibria

harder to sustain than in autarky, since the active retailer now has to compensate two manuf. for not selling to his rival.

We show that such an equilibrium can only exist if there is sufficiently little differentiation between retailers (b≥0.61803).

Equilibrium prices are the same as in the foreclosure equilibrium in autarky.

Retailers compete to foreclose their rival and in the process transfer their entire profit to the two manuf.

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Free Trade - Non-exclusive equilibria

• There are two possibilities:

1. each retailer deals exclusively with one manufacturer

2. at least one retailer buys from both manufacturers under a non-exclusive contract.

• Derive equilibria in four steps:- Prove that case (2) cannot occur in equilibrium, by showing

that a deviation to dealing with a single manuf. is profitable.- Calculate equilibrium wholesale prices when each retailer

buys from a single manufacturer.- Show that proposed contracts are best responses.- Verify necessary condition for existence.

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0 1b

0,73205

Exclusive

Non-exclusive

0b

0,67209

Non-exclusive

Exclusive

1

Free Trade

Autarky

Buyer Power

0,61803


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Effects of Trade Liberalization – contracts and prices

Buyer Power


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Buyer Power

Effects of Trade Liberalization – social welfare


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Buyer versus seller power

Buyer Power


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Buyer versus seller power

• Size of the rents accruing to the retailers and to the manufacturers differs depending on who has the power to make take-it-or-leave-it contract offers.

• More importantly, equilibrium prices and hence the competitive effects of free trade are different.

Autarky • Prices are at least as high under seller power than under buyer

power.• Reason: the domestic manufacturer is able to eliminate the

competition between retailers by setting a wholesale price above marginal cost and extracting rents through the fixed fee.

• Under buyer power, retailers only internalize the effect of their wholesale price on the manufacturer, but not on the rival retailer. Hence competition is tougher under non-exclusive contracts.

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Free Trade

Now compare retail prices in free trade:• When there are non-exclusive contracts, retail price are the

same under both buyer and seller power.• But exclusivity, which occurs only under buyer power, leads to

higher retail prices

Buyer Power


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Buyer Power


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Conclusions

• Opening up markets to the forces of international trade has traditionally been seen as a means of inducing domestic industries to become competitive and more efficient.

• Monopoly rents are diluted, consumers gain from competition.

• Is this really true or can the rents that manufacturers may lose

be captured by retailers, wholesalers and other intermediaries, especially once these become unavoidable agents in the process of reaching consumers?

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We obtain some surprising results:

1. Under some circumstances the rents can be completely captured by manufacturers once free trade is introduced, even if additional sources of supply are available in free trade and even if there is (imperfect) competition among retailers.

2. Hence buyer power does not necessarily mean that retailers capture the rents in free trade.

3. Price competition can be lower in free trade than in autarky because an equilibrium in which some retailers are foreclosed may be easier to sustain in free trade.

4. Hence economic integration may lead to a smaller increases in competition and smaller welfare gains than suggested by traditional models.

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What comes next?

• We do not yet have a theory of buyer power in an international context.

- Buyer power in our model is exogenous: the retailers have all the bargaining power irrespective of the trade environment.

- We only spell out the implications of the existence of buyer power – and find that it matters!

- We have nothing to say about the idea that buyer power might be a by-product of freer trade.

• Need to endogenize market structure in retailing and in manufacturing to capture general equilibrium effects.

Buyer Power


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International Trade and the Structure of Retail Markets

Horst Raff (University of Kiel)

Nicolas Schmitt (Simon Fraser University)

Heterogeneous Retailers


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How does the retailing sector respond to globalization, especially the increased scope to import consumer products?

1. What are the effects of trade liberalization on the structure of retail markets and retail competition?

2. How does retail market structure affect the transmission of external shocks (fall in trade costs, exchange-rate changes) into consumer prices?

3. How does retail market regulation affect consumer prices, imports, pass-through of import prices?

We address these questions in a model of trade with heterogeneous retailers.



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Three stylized facts:

1. Retail market structure has changed dramatically

• Strong increase in market concentration due to growth of big national chains operating large stores.

• Retailing is often much more concentrated than manufacturing.

2. Big retailers handle a massive amount of trade

• Wal-Mart accounts for over 15% of US imports from China (Basker/Van).

• Big retailers are three times as likely to import from China as small retailers.

• Expansion of big retailers accounts for 19% of the growth in US consumer good imports from China.



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3. Distribution margins account for up to 50% of consumer prices

• Changes in the cost structure and competition in the retail sector will have strong effects on consumer prices and the demand for imports.



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Policy Issues:

1. Pass-Through from Import to Consumer Prices

• Determines the gains from trade for consumers.

• Monetary policy and the choice of exchange rate regime depend on how external shocks are passed through into consumer prices.

• Pass-through from import into consumer prices appears to be very low (Exchange-rate disconnect puzzle).

• Retail sector plays a central role in explaining the seemingly low degree of pass-through since retail margins are such a big part of consumer prices.

• Which retail sector characteristics (trade costs, technology, productivity distribution,…) lead to the low pass-through rate?



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2. Retail-Market Regulation

• Some countries (France, Japan, Belgium, Italy,…) have a tradition of restricting the size of retail establishments.

• This affects retail market structure, imports and consumer prices.

• It limits the pass-through of import prices.

• France: consumers complain that their purchasing power is falling and that they don’t have access to cheap foreign goods.

• US: poor consumers benefit from the low-priced goods that Wal-Mart and other big retailers import from China (Broda and Romalis, 2008).



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How does trade liberalization affect retail markets?

Retailers source goods through two channels:• domestic sourcing – includes domestically produced goods and

goods imported by third parties;

• imports.

Only the big retailers choose imports:• low marginal cost (bypass additional layers of intermediaries, identify

cheapest supplier,…)

• high fixed cost (operating buying offices, searching for suppliers, developing products, training suppliers, monitoring quality,…)



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Hence trade liberalization favors big retailers:• they tend to buy more imports,

• grow even bigger as a result,

• displace smaller competitors.

Evidence:• Retail segments where the share of large retailers is high

correspond to segments where the share of imports is high as well (Canada 2003: clothing, clothing accessories, footwear, audio, video, small electrical appliances, toys and games).

• US imports from China and other less-developed countries in 1997-2002 rose especially quickly in retail sectors with the largest consolidation into chains (Basker and Van, 2008b).



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Modelling issues1. Significant size differences among retailers

• Few big, efficient firms and many small, inefficient firms.

• Pareto distribution of productivity provides a good fit (Campbell and Hopenhayn, 2005).

2. Fixed cost of direct imports

• Cost of maintaining buying offices, cooperating with foreign partners to bypass intermediaries, acquiring information,...

3. Endogenous mark-ups• Important channel for pass-through.

Melitz, Ottaviano, Market Size, Trade and Productivity, REStud 2008.



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Model of firm heterogeneity in retailing

Continuum of retailers selling in the domestic market:

• retail services are non-tradable

• retailers are differentiated (products, retail location or services differ)

Consumers:

• L consumers each supplying 1 unit of labor

• Each consumer has quasi-linear preferences over goods sold by retailer i and the numeraire good y:



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Market demand faced by retailer i,

where

N is the mass of consumed varieties,

is the average retail price.



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Technology

• Labor is the only factor of production (price of labor = 1)

• Labor requirements:



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Pareto distribution of cost over support

Monopolistic competition in retailing:

• Retailers take the average industry price as given,

• earn zero profit in equilibrium



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Profit maximization by retailer i:

• When sourcing domestically:

• When relying on direct imports:

Profit maximizing outputs:



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Maximized profits:

Marginal cost at which a retailer is indifferent between domestic sourcing and direct imports:

Expected-zero-profit condition:



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Equilibrium

Endogenous variables:

How does trade liberalization (marginal decrease in t) affect the equilibrium values of these variables?

• Examine the signs of and

• Then determine how the average retail price, number of active retailers, average output and the variance of output change with trade liberalization.



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c

Profits

Imports Domestic

Sourcing

Inactive

Profit functions (gross of sunk entry cost)



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c

Profits

Imports Domestic

Sourcing

Trade Liberalization

Inactive



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Effects of Trade liberalization

More retailers source goods from abroad Least efficient retailers become inactive

This implies:

• Lower average retail price

and, if the trade cost is sufficiently small,

• Higher average output, lower output variance

• Lower mass of active retailers



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1. Pass-through of import prices

into

consumer prices of imported goods

consumer prices of domestic goods

average consumer prices



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Pass-through

First term: mark-up (share of cost savings passed on to consumers) times expected import share

• Import share depends on trade cost and k (high k = distribution skewed toward inefficient retailers)

Last three terms (from selection effect):• fall in expected retail cost

• lower mark-up for domestically sourced goods

• Higher import share/prob. that a good is imported

Overall pass-through rate can be greater than unity.



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2. Retail Market Regulation

France: “Loi Raffarin” Japan: Large-Scale-Retail-Store Law Regulation acts like a constraint on the sales of the most

efficient firms. How does this affect

• retail market structure,

• consumer prices,

• imports,

• pass-through of import prices?



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Critical value of the marginal cost at which a firm is just constrained (assuming that the firm for which the constraint is just binding is an importer):

What are the effects of a tightening of constraint ?

• Even less efficient importers will now be constrained.

• Constrained retailers raise their prices.

• Residual demand for unconstrained retailers rises.



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c

Profits

Direct

Imports

Domestic

Sourcing

Profits of unconstrained firms



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What happens to the average retail price? Constrained firms raise their price, and the likelihood that a

firm is constrained is higher. Greater probability that inefficient retailers remain active. But retailers are more likely to source (cheaper) goods from

abroad.



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Pass-through of import into consumer prices

Constrained firms do not change their retail price when import prices fall.

Only unconstrained firms lower their price in response to a fall in import prices.



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Retail Competition and Welfare

Competition: Herfindahl Index

Welfare effect



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Conclusions

1. Trade liberalization changes retail market structure and reduces average retail prices:

More direct imports Small retailers are forced to shut down



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2. Pass-through of import into consumer prices:

Incomplete and increasing when trade is liberalized Consistent with empirical evidence

• Pass-through has increased over time (Campa, Goldberg).

• Differences in pass-through rates in the Euro area are driven by differences in openness to non-Euro-area imports (Campa, Gonzales Minguez, 2006).



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3. Retail Market Regulation

Raises the likelihood that inefficient retailers survive Induces more retailers to source from abroad Tends to raise average consumer prices Tends to reduce pass-through



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Raff/SchmittManuf. and Retailers in

the Global Economy68

Manufacturers and Retailers in the Global Economy

Horst Raff (University of Kiel)

Nicolas Schmitt (Simon Fraser University)


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1. Increased importance of services in general and wholesale/retail trade in particular• US employment fell in manufacturing between 1970 and 1990 but

rose by 71% in wholesale/retail trade;• US retail industry is second largest industry in terms of employment

(10.5% share).• In Canada, retailing accounted for 12% of employment in 2004.• 50-60% of retailer expenditure on inputs is on labor.• Retailing contributed 22% to productivity growth in the business

sector between 1990 and 2003.

2. Retailers are becoming bigger, retailing more concentrated

• More varieties,• Greater average size,• Higher ratio of square footage to sales.

Stylized Facts


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3. Retailers have become gatekeepers of consumer goods markets.

• Slotting allowances (lump-sum payments made by manufacturers to retailers to carry their products) have become an important feature of retailing.

• Slotting allowances started in US in the early 1980s.• They exist now in groceries, tobacco, household supplies, health

and beauty aid, textiles, footwear, automotive parts, etc;• Typically explained by retailers choosing among many new

products, many of them likely to fail;• Slotting not used by all retailers in a given segment and they vary a

lot across products.

Stylized Facts


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1. What explains the reallocation of labor from manufacturing to retailing, market concentration in retailing, the rise of slotting allowances?

• Trade liberalization: increase in the number of imported varieties

• Technological change: new technology has made it cheaper to handle larger variety of goods

Research Questions


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2. How does trade liberalization affect product variety, prices and welfare when retailers act as gatekeepers?

We address these questions in a general equilibrium model of manufacturing and retailing.

Research Questions


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1. Retailing (Feenstra and Ma, 2008)• Multi-product retailers choosing assortment and retail prices

• Each retailer takes into account the impact of adding a variety on the demand for the other varieties it sells (cannibalization)

2. Manufacturing (Krugman, 1980)• Monopolistic competition

• Single-product manufacturers

3. Wholesale market (Raff and Schmitt, 2009)• Bargaining between manufacturers and retailers over the wholesale

price

• Two-part tariff

Model Components


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I. ModelKey elements:

• Dixit-Stiglitz preferences,

• only factor of production: labor with endowment L.

Preferences:

Demand for variety i:

where is aggregate expenditure on differentiated products

Model

L


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R retailers, all carrying different varieties

Retailer 1 carries the first M1 products, retailer 2 carries the following M2 products….

Total mass of varieties consumed

The CES price index is:

Model


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Symmetry: each retailer sets the same retail price for all the products he sells:

CES price index

Price elasticity of demand

where market share of retailer r is:

Model

1

1

1

1R

rrr pMP

rrr

r

r

r ssy

p

p

y

)1(

R

r rr

rrR

r rrr

rrrr

pM

pM

ypM

ypMs

1

1

1

1


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Technology

Retailing labor requirement:

Manufacturing labor requirement to produce variety i:

Model

rr Mkkl 10


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Wholesale Market

Two-part tariffs

w – wholesale price

T – transfer/fixed payment from the manufacturer to the retailer (slotting allowance if T is positive).

Bargaining:

• Simultaneous bargaining between retailer-manufacturer pairs

• Division of surplus of each pair through “efficient” bargaining

Model

rr Tw ,


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II. Equilibrium Retailer maximizes:

First-order conditions:

• with respect to retail price leads to:

• with respect to retailer’s assortment, M:

marginal benefit is reduced by the cannibalization effect

Equilibrium


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Total surplus for a manufacturer-retailer pair:

This surplus is maximized for a wholesale price>mc (due to cannibalization effect):

Externality since each retailer-manufacturer pair ignores the impact of its deal on other retailer-manufacturer pairs.

The zero-profit condition for manufacturer then determines T:

Equilibrium


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Equilibrium

Zero-profit condition for retailers

Labor-market clearing condition

We can now solve for the equilibrium values of:

MRpyTw ,,,,,




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# of retailers:

Retailer’s assortment:

Retail price:

Output per variety:

Slotting allowance:

Equilibrium


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Equilibrium

Proposition 1: The equilibrium slotting allowance is i. increasing in the retailer fixed cost ko and

cost per variety k1

ii. decreasing in the manufacturer fixed cost

iii. increasing in the elasticity of substitution




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III. Second-best Allocation

# of retailers:

Retailer’s assortment:

Output per variety:

Retail price:

Equilibrium


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This implies:

Excessive product variety implies that too much labor is devoted to distributing these varieties as opposed to producing output of each variety.

Equilibrium


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IV. Product market integration and technological change in retailing

What are the forces driving the structural changes in retailing and manufacturing?

• Shift in employment from manufacturing to retailing

• Retail market concentration

• Rise in slotting allowances.

Can we link these changes to market integration or technological change?

Comparative Statics


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Economic Integration

A. Product market integration with C countries

Market size remains the same for retailers (retail services are non-tradeable).

Market increases for manufacturers: each can now sell to (and spread its fixed cost over) C markets.

Per-market fixed cost is equal to

Adjusted labor-market clearing condition:

LRMyC

kRMRk

10


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Proposition 4: Product-market integration:

i. leaves the number of retailers unchanged,

ii. raises the product assortment carried by each retailer,

iii. raises the total mass of varieties available to consumers,

iv. raises slotting allowance per variety

v. shifts labor from manufacturing to retailing.

Economic Integration

Labor saved through decrease in domestic varieties is reallocated to retailing, enabling retailers to carry more imported varieties.

Slotting allowances increase as the quasi-rents earned by manufacturers fall by less than the fixed cost.


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Technological Change in Retailing

B. Technological Change in Retailing

How is the equilibrium affected by a marginal reduction in k1 at the expense of a marginal increase in ko ?

Proposition 5: Technological change in retailing

i. increases retail market concentration by reducing the number of retailers and increasing product assortment of each retailer,

ii. has ambiguous effects on the allocation of labor between manufacturing and retailing and on the size of slotting allowances.


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V. Welfare and Policy Implications

Fundamental distortion in the relationship between multi-product retailers and manufacturers.

Product-market integration does not reduce this distortion, although welfare rises: consumers spread their income over a greater variety of goods.

Retail Market Integration Equivalent to full market integration: goods are simply traded by retailers

instead of manufacturers. Greater number of retailers in the C countries so that the market share

of each retailer falls.

Welfare


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Welfare

Proposition 6: Retail market integration

i. moves the economy closer to the second best,

ii. raises social welfare by more than product market integration.

Retail market integration implies that consumers buy from a larger number of retailers, each carrying a larger assortment.

As retailer market share falls, the cannibalization effect becomes smaller.

The wholesale price moves closer to marginal cost.


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1. Reallocation of labor from manufacturing to retailing and rise in slotting allowances are consistent with product-market integration.

2. Rise in retail market concentration is consistent with technological change in retailing.

3. Product-market integration raises social welfare but does not address the inefficiency created when big, multi-product retailers deal with small, single-product manufacturers.

4. Retail market integration moves the economy closer to the second best, hence yields bigger gains than product-market integration.

Conclusions


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Relation to the Literature

Effects of trade on retail market structure:

Raff, Schmitt (2010): heterogeneous retailers face fixed cost of importing, trade liberalization raises market concentration in retailing as the big retailers get bigger and the small retailers are forced out

Eckel (2010): increase in international product variety raises retailer fixed costs and leads to market concentration

Basker/Van (2009): economies of scale in importing allow a chain store to take markets away from small, independent retailers.


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Retailer (buyer) market power may have negative effects on the gains from trade:

Raff, Schmitt (2009): gains from trade are generally smaller in markets with buyer power compared to markets with seller power and may even be negative if trade leads to more exclusive dealing.

Eckel (2010): possible losses from trade when greater market concentration allows retailers to raise their mark-up.


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Growing literature on intermediation in international trade.

Raff, Schmitt (2005, 2006)

Antras, Costinot (2010)

Akerman (2010)

Blum, Claro, Horstmann (2010)

AER P&P (2010)


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Greasing the Wheels of International Commerce: How Services Facilitate

Firms‘ International Sourcing

Peter Debaere (Virginia)Holger Görg (Kiel)Horst Raff (Kiel)


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What role do services play in the international sourcing of material inputs?

1. Does better access to services induce more offshoring by manufacturing firms?

2. How crucial is access to local services?

1. Does this effect differ across firms?

We examine these questions both theoretically and empirically using firm-level data from Ireland.

Research Questions


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1. Increased importance of global production networks• Firms pursue complex offshoring strategies• Imports of intermediates from many foreign suppliers

2. Global production requires “intermediation” services such as transportation, financing, insurance,…. • Services grease the wheels of international commerce (Jones and

Kierzkowski, 1990).

3. Large service sector geared to facilitating offshoring.• Supply-chain management.• Third-party logistics firms (UPS, DHL,…) coordinate and integrate a

fragmented value chain.

Observations


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Trade literature on offshoring (e.g. Antras/Helpman) has so far largely ignored the link between services and offshoring.

Exceptions:

• Jones and Kierzkowski (1990)

• Deardorff (2000)

• Long, Riezman, Soubeyran (2005)

Huge business literature on supply-chain management that explores how this link can be organized and optimized.

Literature


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Model that explains the sourcing decision of individual firms as a function of:• Availability of local services

• Firm characteristics – labor productivity, size,…

Empirical analysis:• Plant-level data from Ireland on domestic and international

sourcing of materials and services.

• How is the ratio of imported materials to total sales affected by firm characteristics and the availability of services (number of service firms in different regions in Ireland)?

Structure of the Paper


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1. Nearly all firms in Ireland source some materials from abroad.

2. How much do they import relative to total material input or total output?

How does this fraction depend on the productivity of the firm? How does it depend on the availability of local services?

Model: Melitz, Ottaviano, Market Size, Trade and Productivity, REStud

2008. Raff, Schmitt, Imports, Pass-Through, and the Structure of Retail

Markets (2009).

Modelling Issues


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International sourcing by heterogeneous firms

Continuum of final-good producers selling in the local (Irish/European market):

• Differentiated final products,

• monopolistic competition in final goods, perfect competition in intermediates.

Consumers:

• With quasi-linear preferences:

Model


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• Market demand faced by firm i is:

where

N is the mass of consumed varieties,

is the average price.

Model


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Technology

• Sunk cost of market entry:

• Production of a finished good requires c units of labor and one unit of a composite intermediate good x.

• Intermediate x combines a domestic input, z, and an imported input, m, according to:

• Labor productivity is Pareto distributed:

Model


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Two options for importing materials

1. Use local services to organize supply chain (mode D):

• Variable cost of imported materials (plus services) =

• This cost depends negatively on service availability.

2. Internalize the supply chain or import services (mode I):

• Variable cost of imported materials = 1

• Fixed cost of internalization/imports:

Model


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Conditional demands for imported intermediates:

Cost functions for composite intermediate input:

Profit maximization by firm i:

Model


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Profit-maximizing outputs:

Profit-maximizing prices:

Model


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Maximized profits:

Marginal cost at which a firm is indifferent between buying services on the market and internalizing services:

Expected-zero-profit condition:

Model


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c

Profits

Mode I:

Internalize

services

Mode D: use

domestic services

Equilibrium

Inactive

Profit functions (gross of sunk entry cost)


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Endogenous variables:

Firm-level observations:

Spending on domestic materials, z Spending on imported materials, m Sales revenue: pq

How does service availability affect m/(pq)?

Equilibrium


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Effects of Service Availability

For mode-D firms a thicker service market implies a higher ratio of imported intermediates to sales:

• Substitution toward imported materials

• Lower output price

Equilibrium


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Effects of Service Availability

Mode-I firms are only indirectly affected by service availability:

• no substitution effect,

• price of output falls.

Equilibrium


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Empirical Implications

Ratio of imported materials to sales• depends positively on availability of local services,

• is higher for more productive (lower c) firms.

Most productive firms • internalize/import services,

• and therefore are not directly affected by local service market thickness.


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Empirical model

Plant i, industry j, region r, time t. Thickness measure: thickness of services in industry j

and region r in which firm i operates at time t. Controls X

• Labor productivity of firm i (firm heterogeneity)

• Size, dummies for exporters, foreign and domestic multinationals (firm heterogeneity, internalization)

• Industry services intensity, industry intensity of use of local services

Dummies for three digit industry, region, time


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Data

Plant level data for Ireland: 2000 to 2004• Annual Business Survey of Economic Impact• Survey of plants with at least 10 employees• Plants in manufacturing as well as (internationally tradable)

services• Provides information on materials and services purchases,

industry, nationality of ownership

In 2004, 1206 manufacturing plants, of which 343 foreign MNEs, 108 Irish MNEs, 557 domestic exporters, 198 purely domestic

In 2000 also information on domestic multinationals

3 regions: Dublin, South, Border/Midlands/West


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Data

Standard stylized facts:• MNEs are bigger, more productive than local firms• Exporters are bigger, more productive than non-

exporters

Material imports/sales revenue:• 20% on average• max: 27 % Transport Equipment (NACE 34)• min: 12 % Food (NACE 15)

Service thickness in each region:• # of service firms• # of service MNCs vs. domestic service firms• “effective thickness”: # of service firms x service use

in industry j


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Alternative service availability measure

variation across industries based on input-ouput linkages:

• Number of service firms in sector s:

• Inputs from service sector s used in manuf. sector j as as a percentage of output of industry j:

• Number of manufacturing firms in region r:


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Data


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All firms vs. subgroups (domestic and foreign MNEs, local firms, exporters)

Industry vs. firm-fixed effects Different specifications to deal with endogeneity

Estimation Results


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Services firm thickness 0.098**

Foreign MNC services

firm thickness

0.008 0.012

Domestic services firm

thickness

0.06** 0.056**

Labor productivity 0.007 0.007 .-0.013**

Dummy domestic MNC

0.018*

Dummy foreign MNC 0.05***

Dummy exporter 0.051***

Firm size 0.007**

Observations 6937 6937 6937

R-squared 0.16 0.16 0.2

Table 5: All PlantsIndustry-Fixed EffTime, Region Eff.LHS ln(imp/sales)

Estimation Results


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Table 5: OLS, all plants,industry,time, region dummies

Dependent variable: ln(imported materials/sales)


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Table 5: OLS, subgroups, industry, time, region dummies.


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Table 7: exporters only, firm-fixed eff., time eff.



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Robustness checks

Endogeneity of service availability measure

• Dummies!

• Fixed effects.

• IV estimator using regional housing price index, first and second lags of availability measures as instruments. Valid instruments. Cannot reject exogeneity of variables (Durbin-Wu-Haussman test).

Include more time-varying variables at the region and industry level to alleviate concern that availability may pick up only regional time-varying characteristics.

Use alternative dependent variables:

• Imports relative to total inputs

• ln(exports*imports/sales)


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Conclusions

Availability of services is important for the decision to import material inputs.

This is especially so for local Irish firms. Multinationals are not affected by the availability

of local services (may internalize services provision or import services).

Evidence that services indeed grease the wheels of international commerce.


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Year Imported materials / Revenue

Services firm thickness

mean Std.dev. mean Std.dev. 2000 0.212 0.147 135.23 1.71 2001 0.200 0.151 150.96 1.77 2002 0.188 0.149 163.20 1.73 2003 0.181 0.147 175.21 1.68 2004 0.190 0.146 149.16 1.64

Data


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Documents

International Trade, Firm Heterogeneity, and Intermediation Horst Raff, University of Kiel